Weekly Drive: July 28 to August 1, 2014

Welcome to the first edition of our new weekly commentary piece. My goal is to use this forum as a way to summarize economic and market activity from the prior week while providing insight from my seat on the Investment Committee and trade desk.

THE KEY ECONOMIC LANDMARKS WE PASSED

1. Q2 GDP: 4.0% vs. 3.0% est, Q1 revised to -2.1% from -2.9%
After a dismal Q1, the U.S. economy roared back to life in Q2 with a higher than estimated reading of 4.0% growth. As anticipated, inventory restocking was a large component. On a related note, revisions were made to 2011-2013 which brought GDP down by 0.2% over the period. I highlighted a few key takeaways from the Q2 report in Figure 1.

Figure 1

2. Pending Home Sales: -1.1% vs 0.5% est
The number of houses under contract slipped in June even after mortgage rates have backed off from the beginning of the year. Buyers are facing challenges like supply shortages and tight lending. The National Association of Realtors’ Pending Home Sales Index stands 7.3% below June 2013’s level. Existing home prices are slowing. The median price in June rose only 4.3% YoY. Regional activity for June is displayed in Figure 2.

Even though the NFP number was a bit worse than forecast, it still remains in the thumbs up range (i.e. 200K+). The 15K upward revision to prior months helped bring the net effect closer to estimates. Also on the labor front, the participation rate ticked up and consequently the unemployment rate followed suit. Gains were seen across the board in manufacturing, construction, business services, etc and much of the workers were full-time as opposed to the part-time heavy June report. Earnings growth remains subdued and points to additional slack in the labor market while the “underemployment” rate (U-6) moved a bit higher.

The strongest ISM number since early 2011 should provide confidence in the economic recovery. New orders, production, and employment all grew at a more rapid pace in July. Inventories dipped but remain well above the level associated with growth and January’s bottom.

LAST WEEK’S MARKET IN THE REAR-VIEW: “Sell high yield, buy short duration”

Most of the desk chatter I saw centered around the rotation out of high yield ETFs such as JNK, HYG, and HYLD into short duration exposure names like FLOT. With the Fed continuing to taper its asset purchases and the prospect of a rate hike closing in, money is starting to re-adjust in the fixed income complex. As of Friday morning, HYG saw nearly $750M in outflows. The FOMC rate decision and Q2 GDP release brought rates back in focus. The yield curve is flattening and recently the 2-10 Yr Treasury spread reached its lowest level of 2014.

LOOKING THROUGH THE WINDSHIELD

Economic

Trade Balance – Since last winter, the trade deficit has widened out to reach levels last seen in 2012 as consumers import more goods. A wider deficit means a larger negative impact in GDP. Information for June 2014 is set to release on Wednesday and will provide more insight on whether the 4.0% Q2 print stays.

Unit Labor Costs – I have been watching for any indication of a pick up in wage inflation and the preliminary release for Q2 on Friday is on my list of things to watch.

Market

Small & Mid Caps – The spread between small cap and large cap stocks (as measured by the Russell 2000 and S&P 500) widened as the month of July progressed. The month end gap elevated to >4.5%. We will continue to monitor this trading action and see if it differs from a similar environment earlier in the year.

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